Remarks of Richard Walker
at the National Press Club
Washington, D.C., April 5, 1999
A Bull Market in Securities Fraud?
Good afternoon and thank you Russell.
I am honored to have been invited by the Corporate
Crime Reporter to speak here today at this magnificent
Washington institution where government officials
regularly engage in a dialogue with the press. While I
know that this audience is not comprised solely of
members of the press, I'd be remiss if I didn't take this
opportunity to thank those of you that are. I thank you
not just for having me as your luncheon speaker but also
for the work that you do in helping us leverage our
resources to accomplish our primary mission -- protecting
investors and safeguarding our capital markets. You have
been our partners in getting our enforcement message out
far and wide, where it will have the greatest chance of
deterring potential wrongdoing and protecting the largest
number of investors.
I was asked to offer my views today_ and they are my
views and not necessarily those of the Commission or its
staff -- on whether we are experiencing "A Bull Market in
Securities Fraud." The short answer is yes. Investors
are being magnetically drawn to the markets either
because they can't help but notice the Dow break new
records almost daily or because they are trying to get
rich quick by finding the next E-bay, Amazon, or anything
"dot com."
This rush of investor money hasn't escaped the notice
of fraud artists, who have a knack for following the
action. As Jane Bryant Quinn recently wrote: "As the
stock market rises, so does the amount of fraud. If
Willie Sutton were alive today, he wouldn't rob banks,
he'd set up a thieving stockbrokerage house."
What is more notable than the current rise in fraud
itself is the medium by which much of it is taking place.
As the Dow has soared over the last decade, so too has
the Internet experienced explosive growth. History will
no doubt record the evolution of the Internet as among
the most significant developments of all time, in the
same league as the invention of the printing press or the
discovery of electricity. By providing cheap, quick, and
easy access to vast sources of investment opportunities,
the Internet has, among other things, transformed the way
we invest. Unfortunately, the access it has provided to
potential investors on a relatively anonymous basis has
also made the Internet a favorite tool for many con
artists. For example, it has helped to revolutionize the
old fashioned boiler room. Who needs an army of
telemarketers when you can reach millions of investors
worldwide with the simple click of a mouse? A prominent
state regulator has aptly noted, "Any con artist not on
the Net should be sued for malpractice."
Whereas policing insider trading was perhaps our
greatest enforcement challenge a decade ago, policing the
vast universe of the Internet is unquestionably our
greatest challenge today. What makes this challenge even
tougher for us is that we do not have available to us new
or additional resources to do the job, although some
members of Congress have expressed interest in making
additional resources available. At least currently,
however, policing of the Internet comes on top of all the
other traditional types of frauds that have occupied our
staff full time in the past.
With that introduction, I'd like to share with you
what we are doing at the SEC to combat Internet fraud and
help maintain our markets' reputation as the fairest and
most trustworthy in the world. Despite what I've said so
far about the enormity of the challenge that the Internet
poses for us, I believe that the future of the Internet
is very bright in terms of our ability to detect,
prevent, and punish fraudulent conduct. I've already
seen that our efforts have made an important difference
in the way that some securities activities are conducted
on the Net, and I'm very excited about some of the
projects we have underway currently which will be
revealed in the coming weeks and months. In particular,
our Chairman will be speaking here early next month, and
I know he intends to fill in some of the details of how
we are aggressively expanding our enforcement efforts to
fight Internet fraud.
But first, let me set the stage as to how we came to
this historical point in time.
The past decade has witnessed more explosive growth
in our markets and more rapid technological change than
at any other time in history. At the beginning of 1990,
the Dow hovered in the 2,700 range. Just two weeks ago,
it rained confetti on the floor of the New York Stock
Exchange when the Dow broke the 10,000 barrier for the
first time in history. Record numbers of individuals
have shown their faith in our markets by putting more
money in stocks and securities than ever before.
We have also seen revolutionary advancements in
technology during this past decade. Ten years ago, the
word "Internet" was not in most people's vocabulary.
Today, a reported 147 million people use the Internet
worldwide with predictions that this number will increase
to 700 million within five years. To put that number in
perspective, one in five American households has access
to the Internet.
The net result, if you'll forgive the double
entendre, is that not only are more people investing
today than ever before, but more are doing so via the
Internet. The Net has transformed our markets and brought
significant benefits to investors. Investors are turning
to the Net both to gather investment information and to
execute their trades. The benefits to investors are
mainly enhanced access to information and lower costs to
execute trades. Nearly 14 percent of all trades are now
conducted on-line.
At the same time, however, the Internet has opened
new avenues for securities fraudsters to swindle the
investing public. There is indeed a bull market in
Internet securities fraud taking place. The problem is
of such great concern that hearings on the subject were
held two weeks ago by the Senate Permanent Subcommittee
on Investigations, chaired by Senator Susan Collins. I
testified at that hearing on the Commission's Internet
enforcement program.
The Commission's program is one of humble origin. We
began to surveil the Internet for fraud in 1995 at a time
when our equipment and technological support barely even
allowed us to obtain access to the Internet. We
immediately witnessed some of the most outrageous frauds
we had ever seen. One in particular stands out. Early
on we received a complaint about an advertisement for the
"Online Scam Guide." The guide proclaimed to have over
1,001 ways to scam people on the Internet. We put a
crack team of cyber gumshoes on the matter who were able
to track down the phone number of the mastermind behind
the scheme. We called and were told that the perp was
not home. We asked when the perp would be available, and
were told that he would be available later in the
afternoon -- he was not yet home from school. At 4:30
p.m., we were able to get the culprit on the phone. We
read him our standard warnings including advising him of
his right to counsel and other important due process
considerations. He responded by bursting into tears and
pleading with us: "I am only a teenager. Please don't
tell my mommy." Now, from time to time we require
notification of a defendant's employer of malfeasance; I
don't know if we've ever required parental notification.
In this case, however, the remedy proved to be very
effective. The child's mother assured us that she would
take care of the matter, and that we needn't worry about
the offensive web site anymore. Given the successful
resolution of this matter, it occurs to me that parental
notification might be a powerful new remedy that Congress
might consider for the new generation of cyber-scamsters.
Since cracking that caper, we have brought dozens of
Internet-related enforcement actions, the majority during
the last year. Each case involves fraud. The
substantial increase in Internet cases brought last year
marks a trend we expect to continue. It's impossible to
log onto the Internet and not be bombarded within minutes
with any number of "get rich quick" investment
opportunities. For example, how many of you have
recently received an e-mail offering free stock for
visiting a particular web site? Call me a cynic but in
my line of business if there is one certainty it is that
nothing in life comes for free. These giveaways are
illegal more often than not. Why? Because, at a
minimum, they are no different than an unregistered sale
of securities. You can expect to hear more from us on
this topic soon.
Our experience patrolling the Internet leads us to
conclude that the scams taking place online are the same
basic scams that have long plagued our markets. They
mainly break down into three categories. The first is
sham offerings. Here, con artists create fancy web sites
and use mass e-mails, or "spam," to pitch securities in
offerings that either do not exist or are misleading.
These scams are often exotic. For example, we have seen
interests pitched in eel farms, coconut plantations, and,
my personal favorite, projects to explore near earth
asteroids.
The second category of Internet fraud is market
manipulation _ most often the "pump and dump" scheme.
Here, fraudsters circulate widely false and misleading
information to drive up a stock's price, then sell their
shares at the inflated price. When the scheme is
complete, the share price normally collapses. They work
the other way, too _ a practice known as the
"cybersmear." Often perpetrated by short sellers, this
fraud is intended to driven down a stock price on the
basis of false information. These scams routinely
involve "microcap" stocks -- which are low-priced thinly
traded securities. In conducting these scams, the
Internet has served as the modern day "boiler room"
replacing the traditional army of salespersons working
the phones with scripts in hand.
Finally, we have witnessed illegal touting. This
occurs when promoters are paid to make positive
statements about a company without fully disclosing that
they have been paid to do so. The wealth of information
available over the Internet aids investors only to the
extent it is credible and reliable. If the information
is simply "bought and paid for," investors have a right
to know.
The Commission has already made positive strides
toward combating illegal touting. On October 28, 1998,
we announced our first nationwide Internet fraud sweep,
centering largely on illegal touting. We filed 23
enforcement actions against 44 defendants and
respondents. In total, the touters received for their
services almost $7 million in cash and 2 million shares
of cheap insider stock and options of potentially
unlimited value.
The reaction to the sweep has been overwhelmingly
positive. Investor sensitivity to on-line fraud has been
heightened. We received a record number of visits by
investors to our web site on the day the sweep was
announced. Our on-line complaint center, which normally
receives 120 messages a day, received seven times that
amount in the days following the sweep. We currently
receive between 200 and 300 complaints, on average, every
day. In addition, the sweep produced lively discussions
in chat rooms and other discussion forums and, most
significantly, helped to bring about substantial
improvements in the types of disclosures that accompany
touts. We are not foolish enough, however, to think that
our enforcement work is done. In February 1999, we
brought a follow-up sweep and announced four more actions
against 13 defendants and respondents for committing
fraud over the Internet. And we will continue to bring
actions against touts who either fail to disclose that
they are being paid or whose disclosure is incomplete or
inadequate.
The impact of Internet fraud has been brought to the
fore recently by the Senate Permanent Subcommittee on
Investigations, chaired by Senator Collins. The
Subcommittee has been active in looking at a variety of
fraudulent practices that harm consumers and investors.
Most recently, the Subcommittee held hearings on Internet
fraud on March 21 and 22.
A central issue of the hearings was whether
regulators, including the SEC, have enough resources to
police the Internet. The resource issue is one of great
concern and has not been lost on Capitol Hill or the
press. Just last week, Mike Schroeder of the Wall Street
Journal addressed the issue in article headlined, "Growth
in Internet Securities Fraud Will be Difficult to
Combat." The same day, the Los Angeles Times had a story
titled, "Rise in Net fraud could overtax SEC." While it
is true that our resources are strained by the growth of
Internet fraud, it would be a mistake to underestimate
our commitment to attacking fraud on the Net. I can
assure you that the reports of our demise are greatly
exaggerated. We can and we will spare no effort to fight
fraud in this new medium.
As many of you know, in July 1998, we formed an
Office of Internet Enforcement in recognition of the need
for more coordinated and focused efforts in this area.
The Office is currently comprised of staff who are
Internet experts. They coordinate our enforcement
initiatives which are handled by our entire enforcement
staff of 850. The Office also provides the staff with
training and technical guidance, and helps direct special
projects such as our touting sweep. Finally, the Office
manages our online Enforcement Complaint Center and also
oversees our "Cyberforce." The Cyberforce is a group of
135 staff members who spend time each week surfing the
Net in search of securities fraud. You can expect that
the Office of Internet Enforcement and the Cyberforce
will grow rapidly. Their activities, with the muscle of
the entire Division of Enforcement behind them, should
make believers out of those who think that the task of
adequately policing the Internet is doomed to failure.
We are not naive enough, however, to believe that
even with increased resources we can regularly surveil
every nook and cranny of the Internet. More is needed to
win the war. To this end, we have supplemented our
efforts to fight Internet fraud and microcap fraud with
aggressive investor education efforts as well as a number
of regulatory measures.
Effective investor education is the best line of
defense against fraud. Our Office of Investor Education
and Assistance has done an excellent job of preparing and
distributing a host of educational materials for
investors. In addition, our Chairman, Arthur Levitt, has
held 28 town meetings across the country where he has met
with investors and helped them to understand and identify
the warning signs of Internet and microcap fraud.
On the regulatory front, in February of this year,
the Commission engaged in a number of rulemakings
designed to make it more difficult to engage in microcap
fraud by tightening up the rules relating to the sale of
unregistered securities. Microcap fraud and the Internet
have proved to be a combustible mix with the Internet
acting as a dangerous accelerating agent.
In addition to the progress we have made on the
enforcement, investor education, and regulatory fronts,
we have made important progress in other areas as well,
notwithstanding inherent limitations on our authority.
As you know, the Commission has only civil jurisdiction.
We cannot put people in jail. It has been my experience,
however, that there is a certain breed of bottom feeders
who are simply not deterred by the prospect of civil
injunctions or even stiff monetary penalties. For this
group of fraud artists, civil sanctions are simply a cost
of doing business. There is no other option to achieving
deterrence for them than the threat of a life behind bars
making license plates.
We have worked very closely with criminal prosecutors
to make criminal prosecution a real threat, and our
efforts are paying substantial dividends in the microcap
area. During the last year, Chairman Levitt and I have
met with a number of criminal prosecutors to urge them to
bring more securities cases. And we are committed to
supporting their efforts oftentimes detailing our own
staff to U.S. Attorneys' Offices to assist with the
cases.
I am pleased to report that the level of interest in
criminal prosecutions is on the rise. In the last
several years, we've seen criminal prosecutions of some
of the most notorious broker-dealers and their principals
-- firms such as A.R. Baron and Sterling Foster and
individuals such as Randy Pace of Rooney Pace fame and
Jordan Belfort and Daniel Porush of Stratton Oakmont.
And in one of the most dramatic law enforcement efforts,
the New York Attorney General made a number of arrests at
the firm of Monroe Parker. I can assure you that the
prospect of being led off the premises in handcuffs will
do more to deter a 21 year old kid from committing fraud
than anything we at the SEC can do.
Just as increased criminal prosecution has helped to
make real inroads in the microcap arena, criminal
prosecution of persons committing fraud on the Internet
should likewise help us deliver a strong message to would
be fraudsters. For example, the Santa Cruz District
Attorney's Office recently prosecuted an individual who
had raised a relatively modest amount of money over the
Internet _ $190,000 -- through the fraudulent sale of
securities. The defendant in that matter stole the money
he raised and used it to buy numerous items, including
stereo equipment and groceries. He was successfully
prosecuted and received a whopping 10 year jail term in a
state penitentiary.
In addition to stepped up civil and criminal
prosecution, there is also a possibility that help may be
on the way from Congress. Following the Senate hearings
on Internet fraud two weeks ago, Senator Collins
announced her intention to sponsor legislation that would
provide the SEC with enhanced remedies that would make it
easier for us to bring cases and bar people from the
securities industry. In particular, Senator Collins
announced two proposals that we think could greatly aid
our battle against Internet and microcap fraud. The
first would allow the SEC to bar broker-dealers who have
violated the law not just from the brokerage industry,
but from promoting microcap stocks as well. Under
current law, if we bar a broker from the industry, even
for fraud, he or she remains free to come back as a
so-called "promoter" over whom we have no direct
regulatory jurisdiction. This creates a path for corrupt
brokers to continue to deceive investors. And even a
quick tour of the web makes clear that there is no
shortage of gurus, touters, and promoters claiming with
certainty to have found the "next Microsoft."
Senator Collins also proposed to allow the Commission
to bring follow-up administrative proceedings based on
actions by state securities regulators. State regulators
have been quite active in cracking down on both microcap
and Internet fraud. For example, last June, California
issued nine actions against Internet investment
opportunities, including a floating condominium and a
time machine. I applaud the efforts taken by our state
partners. Their remedies, however, apply generally to
activities solely within their borders. Senator Collins'
proposal would allow us to give their orders nation-wide
effect.
We've faced and surmounted many challenges by
ingenious fraudsters over the years. I'd like to
conclude my remarks by noting what may be a parallel
between the challenge posed by wide-spread insider
trading in the 1980s and that of containing Internet
fraud in the 1990s. In 1981, Fortune magazine ran a
story titled, "The Unwinnable War on Insider Trading."
People had little faith that the Commission could
adequately stamp out this rampant market taint. Twenty
years later, I can say we have made remarkable strides
toward proving that headline false. Does insider trading
still occur? Of course it does, and it will continue to
occur as long as human frailty continues to exist. But
we've unquestionably changed behavior in this area. With
limited exceptions, no longer do we see insider trading
in large magnitude by investment bankers and other Wall
Street professionals, though we still bring cases against
such persons. Former SEC Chairman Richard Breeden knew
that the only way to quash insider trading was by meting
out stiff penalties. You may recall his famous quote
that people who engage in insider trading should be "left
naked, homeless, and without wheels." Those caught
perpetrating frauds on the Internet should similarly
expect us to have little tolerance. Internet fraud
artists will be left naked, homeless, and without modem.
In the insider trading arena, we've clearly
demonstrated that the cops are on the beat and that we
have the ability and the wherewithal to find and
prosecute those who profit from the misuse of inside
information. Our commitment to effectively policing the
Internet is no less strong. Over the years, our
enforcement program has demonstrated remarkable
resilience in adapting to changes in the markets. As we
approach the new millennium, I am confident that we will
continue to provide strong and effective measures to
combat fraud in the age of the Internet. And I am also
confident that you, the press, will continue to help us
leverage our resources as we engage in this endeavor.
Thank you.